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Advisors, an international pension fund manager, uses the concepts of purchasing power parity(PPP) and the International Fisher Effect (IFE) to forecast spot exchange rates. Omni gathers the financial information as follows:

Base price level 100
Current U.S. price level 105
Current South African price level 111
Base rand spot exchange rate $0.175
Current rand spot exchange rate $0.158
Expected annual U.S. inflation 7%
Expected annual South African inflation 5%
Expected U.S. one-year interest rate 10%
Expected South African one-year interest rate 8%

Required:
Calculate the following exchange rates (ZAR and USD refer to the South African rand and U.S. dollar, respectively)

a. The current ZAR spot rate in USD that would been forecast by PPP.
b. Using the IFE, the expected ZAR spot rate in USD one year from now.
c. Using PPP, the expected ZAR spot rate in USD four years from now.

Sagot :

Parrain

Answer:

a. Current spot rate / Base spot rate = Price level in home country / Price level in foreign country

CSR / 0.175 =105 / 111

CSR = (105/ 111) * 0.175

= $0.1655 / ZAR

b. Expected ZAR spot rate / Current ZAR spot rate  = (1 + interest rate in home country) /  (1 + interest rate in foreign country)

Expected ZAR spot rate / 0.158 = (1 + 10%) / ( 1 + 8%)

Expected ZAR spot rate = (1.1/1.08) * 0.158

= $0.1609 / ZAR

c. Expected ZAR spot rate / Current ZAR spot rate  = (1 + inflation rate in home country) /  (1 + inflation rate in foreign country)

Expected ZAR spot rate / 0.158 = (1 + 7%) / ( 1 + 5%)

= 1.07/1.05 * 0.158

= $0.1610 / ZAR

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